Investment in office space in KSA is not very attractive


“Markaz” in its recently released research note has studied the attractiveness of investment in office space in the Kingdom of Saudi Arabia (KSA) and has provided an outlook on the sector. The authors of the report opine that the slowdown in economic activity converted a market from short supplied (triggering developments of 0.5 mn sq m) to oversupplied evidenced by high vacancy rates at 17% and the extent of contraction in rentals (15%) and prices (16%) on an average, mainly due to contraction in demand.

Muted demand: The authors argue that the demand for office space is essentially driven by employment generation in service sector and is highly sensitive to economic activity in the private sector and notes that the same has been experiencing a declining growth trend from 2007. For demand prospects to prosper, strong improvement in economic activity is required and improvements in sentiments alone would not contribute towards increased demand. Real non-oil private sector is expected to return to its trend growth level of 5% experienced in the past five years, which would materialize post 2010, for office space demand to get a boost. Till then, the prospects for businesses will be muted and hence the employment generation and office space demand will be subdued till 2010.

Pouring supply in Riyadh :  The report notes that, while the market in Riyadh is currently haunted by oversupply, the forthcoming supply situation is not coming any shorter. The authors expect c.300,000 sq.m of Class A office space to enter the market during 2009-11 from projects worth 2.5 bn USD which are currently under various stages of construction. A rental study by Markaz indicates that the premium for Class A office building stands at 75% over Class B buildings in Riyadh, signifying the undersupply in this segment even though Riyadh as a whole is facing high vacancy levels. The forthcoming development of Class A offices will continue to be absorbed, however, the demand would be primarily from the current occupiers of Class B buildings and hence would be at a favorable terms to the tenants.

This cross movement would cause the vacancy in Class B buildings to rise further and would trigger the contraction of average rental levels resulting in overall rental slowdown or contraction. Supply during the period 2011-14 quintuples to USD 9 bn dominated by mega projects of which King Abdullah Financial District alone contributes to two thirds of the total supply.

GCC Central Bank : The report also studies about the impact of the location of GCC Central Bank on office space demand and concludes that it would not be significant and would add up to 6,000 to 7,000 sqm to total office space demanded. It also notes that the recent FAR increase by Riyadh municipality for four or five star hotel development disincentives future office space development.

Outlook on other cities : The authors suggest a stable outlook for the sector in Jeddah and estimates the size of demand to be at 60% of Riyadh. Unlike Riyadh, office space rentals in Jeddah contracted by around 8-10% on an average and the current vacancy levels are in the range of 6%. Contraction in rentals occurred as it chased the price correction to the extent of 15% on an average. The report expects office space supply in Jeddah to be at c.150,000 sq.m between 2009-11, just about enough to cater the demand, thus displaying a stable outlook at its best with a possibility of a moderate rise in rentals and prices.

Office space of the twin cities of Al Khobar and Dammam is driven mainly by the head offices of major industrial companies like SABIC, Saudi Aramco etc., who have their own offices and common office space is occupied by finance, real estate and business services and we estimate the size to be at 25% of Riyadh. The market lacks modern office buildings and the demand for them is not huge as well. Rentals corrected in the range of 15-18% and vacancies remained stable at 5%. Thus, the market is in its nascent stage and is not attractive as yet for investment.

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Kuwait Financial Centre S.A.K. 'Markaz', with total assets under management of over KD781 million as of March 31, 2009, was established in 1974 has become one of the leading asset management and investment banking institutions in the Arabian Gulf Region. Markaz was listed on the Kuwait Stock Exchange (KSE) in 1997; and was recently awarded a BBB+ corporate rating by Capital Intelligence Ltd.